Edited version of your private ruling

Authorisation Number: 1012508754007

Ruling

Subject: Deposit paid

Question 1

Are you entitled to a deduction for your share of the forfeited deposit paid on an investment property when the purchase did not occur?

Answer

No.

Question 2

Do the capital gains tax (CGT) provisions apply to your share of the forfeited deposit?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You and your spouse entered into an off the plan contract to buy an investment property and paid a deposit.

On the following day you went to a financial institution to get the finance facility for the investment. The financial institution was happy to lend money for the investment project and you opened up a new account with them.

You later paid further deposits.

When the project was reaching its final stage you went to the financial institution to obtain the loan facility. The financial institution advised that they had changed their policy and could not provide a loan facility for your investment due to the unacceptable security. You complained, however the financial institution merely apologised. No other financial institution would provide you the funds.

As a result you could not settle on the property and the deposit was forfeited.

You are not in the business of buying and selling properties off the plan.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Section 108-5.

Income Tax Assessment Act 1997 Subsection 102-25(1)

Reasons for decision

Allowable deductions

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478, 

· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47, and

· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Generally expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. Accordingly, it follows that where you own an investment property from which assessable income is to be derived; the associated expenses incurred will generally be deductible. However, the essential character of the expense is a question of fact to be determined by reference to all the circumstances.

We acknowledge that you intended to purchase the property as an investment, however, as you were not the legal owner of the property, any expenses incurred are not sufficiently connected to the earning of your assessable income. The contract of sale or any other agreement you had are not regarded as income producing assets and therefore the associated expenses incurred are not an allowable deduction. Furthermore, the expenses are capital in nature. Therefore no deduction is allowable under section 8-1 of the ITAA 1997.

Capital gains tax (CGT)

A capital gain or capital loss may arise if a CGT event happens to a CGT asset. Where a CGT event happens, the CGT provisions are relevant. Section 108-5 of the ITAA 1997 states that a CGT asset is any kind of property, or a legal or equitable right that is not property.

Your contract and associated rights are regarded as a CGT asset.

Where a purchaser forfeits a deposit, either CGT event C1 or C2 occurs. CGT event C1 happens if a CGT asset you own is lost or destroyed. CGT event C2 happens if your ownership in an intangible CGT asset ends by the cancellation, surrender or similar ending.

As both CGT event C1 and CGT event C2 can apply if a purchaser forfeits a deposit, subsection 102-25(1) of the ITAA 1997 provides that the CGT event that is the most specific to the situation is the one to use. The circumstances surrounding the purchaser's default in each case determines which is the more specific CGT event.

As highlighted in paragraph 123 of Taxation Ruling TR 1999/19, if the circumstances are of a genuinely involuntary nature, there is a loss or destruction of the contractual rights and CGT event C1 is the more specific CGT event. For example, if a purchaser defaults because their finance fails, CGT event C1 is the more specific CGT event.

In your case, as the bank would not provide finance, CGT event C1 is relevant.

You make a capital gain if the capital proceeds are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

As you received no consideration on the termination of your contractual rights, you are entitled to a capital loss for your share of the amount of the deposit forfeited. That is, the deposit paid in relation to entering into the contract forms part of the reduced cost base when calculating the capital loss. Please note, the reduced cost base excludes holding costs such as interest. However, any legal fees incurred are included in the reduced cost base.

Any capital loss is shared according to your legal interest in the contract. That is, as you and your spouse entered into the contract jointly, you are only entitled to 50% of any capital loss.